Paul: Thank you so much for the article on deflation - I think that articles (lessons) 10 and 11 are extremely illuminating and should be shared as well.
In the 2nd paragraph of the following excerpt, Jude Wanniski puts his finger clearly on the source of confusion, and goes on a bit later to explain that "in the supply model, there are two types of inflations and deflations..."
I wish in hindsight that I had taken more than the most basic economics course in college 30 years ago. However limited my exposure, I am thankful for the shared insights and experience
of people on this thread to help me understand these important
issues that are shaping our lives so dramatically. Thank you!!
Sincere best wishes,
Richard A. Green
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<http://www.polyconomics.com/searchbase/fles10.html> and
<http://www.polyconomics.com/searchbase/fles11.html>
The following excerpt by Jude Wanniski is taken from the first site.
In a letter to Rep. Barney Frank (Mass.) regarding pending testimony, he wrote:
"Following is an op-ed I wrote for the WSJournal, which they won't run. It might help you tomorrow...
When Federal Reserve Chairman Alan Greenspan testifies this morning
before House Banking on the deflation in Southeast Asia, the first thing he should do is give us a definition of "deflation." In recent weeks, the term has been tossed around in the financial press as if there were general agreement that it means the sudden realization of "bad investments" or market discounting of "excess capacity" in a country or in a region. These in turn produce "falling prices" and banking problems as loans turn sour and the value of collateral shrinks.
The confusion exists because almost all discussion on Wall Street about inflation or deflation occurs in a demand-side model. Demand-side monetarists (Friedmanites) insist that inflation (or deflation) is a monetary phenomenon. Demand-side fiscalists (Keynesians) usually argue that inflation (or deflation) is a problem of the real economy, not the money economy. Supply-siders (classical economists) agree with both. Inflations and deflations can be monetary or real or both at the same time.
Think of a balloon as it inflates or deflates. In the monetarist model, the economy first expands as the Federal Reserve adds money to the banking system. If it adds too much, the banks will make bad loans that inflate the balloon past its productive capacity. The balloon will deflate when the Fed takes too much money out of the banking system in order to fight the inflation. This is why monetarists focus on a slow, steady increase in the money supply.
Keynesians argue that the balloon inflates when government tax and
spending policies cause aggregate demand to increase. To expand the
balloon, the government should lower interest rates or lower taxes or
increase spending. If too much is done, and prices and wages appear to
be rising at a faster clip, the balloon should be deflated by raising interest rates and taxes or cutting spending, in some combination.
In the supply model, there are two types of inflations and deflations.
Monetary inflation is a decline in the monetary standard characterized
first by a rise in the price of gold and thence all commodities.
Monetary deflation is the opposite. Fiscal inflation occurs either when the government throws greater burdens on the economy than it can easily meet, as in wartime, or when it manages a shift from wartime to
peacetime. In either case nominal prices of goods may rise relative to the price of gold until the adjustment is complete.
Fiscal deflation occurs when a war ends suddenly, as World War I did,
and the goods and services being produced suddenly came into surplus.
The government can only avoid a price deflation by buying up the goods
and giving them to people who would otherwise not be able to afford
them. Or, the government can deflate by making an error in tax or tariff rates, which is what the our government did in 1929 when it sharply increased the tariff wall in the Smoot-Hawley Tariff Act.
In that case the monetary standard remained constant at a gold price of $20.67 per ounce, so there was no monetary deflation. But goods and
services our economy planned to export suddenly found no buyers, as
foreigners could not get their goods and services over our tariff wall. The Wall Street Crash occurred because the market knew this would be the inevitable result of a high tariff wall. Unwanted goods and productive capacity piled up on both sides of the wall. The Great Depression occurred as countries tried to offset this fiscal deflation with monetary inflations, which only made matters worse. To this day, monetarists insist the depression need not have occurred if the Federal Reserve had printed less money before the Crash and more money after the Crash. To have done this would have required abandonment of the gold standard, which would have meant a deflation before the Crash and an inflation after the Crash!
In his testimony today, Mr. Greenspan may be asked if he considers the
decline in the gold price this year, from $385 to $310, to be inflationary or deflationary. Because he has repeatedly told congressional committees that he considers gold the most sensitive monetary commodity, to inflations and deflations, it would be hard for him now to reverse himself.
It might be more likely that he would argue the cut in the capital gains tax this year, along with the decline in the burden of government borrowing, has produced a fiscal inflation. Prices are being pulled down by the monetary deflation. Wages and asset prices are being pushed up by the fiscal inflation. One offsets the other, for the time being, although supply-siders contend that the dollar monetary deflation will continue to erode the U.S. and world economy unless the gold price rises closer to $350, which would put the monetary standard in equilibrium.
The problem in Asia, which has now surfaced in Brazil and perhaps the
rest of Latin America, is that the Asian currencies were forced into a
monetary deflation in order to keep up with the falling dollar/gold price. It began with Thailand and spread through the broader currency area.
Where countries compounded the problem, by adding a fiscal deflation
to the monetary deflation, as in Thailand, Malaysia and Indonesia, the
economic problems deepened. Hong Kong and greater China are feeling
the monetary distress through their dollar ties, but at least have not raised taxes to compound the deflation. Earlier this week, Brazil made the stupendous error of raising income tax rates and imposing other surprise austerity measures, which compounded the deflation stress it has felt by its dollar peg.
Members of the Banking Committee who question the Fed chairman
need not be fans of the gold signal in order to query Greenspan. He, after all, has made it clear in the past that it is a signal he values highly. In a recent editorial, The Wall Street Journal has urged him not to allow gold to fall below $300. He should also be asked if he agrees with that advice, and if so, would he recommend a price that would make him feel less uncomfortable about deflation.
(from the testimony record:)
REP. FRANK (D-Massachusetts): You and others
have historically said that the price of gold is an
inflationary indicator, and gold is at a very low rate.
How do you reconcile a consistent view over time to
regard the gold price as an indicator of inflation.
Now gold is at a very, very low rate. Does that mean
that inflation is not much of a problem? Or has the
gold price somehow become an irrelevancy when it
comes to indicating inflation?
GREENSPAN: It's a meaningful tool to evaluate the
expectations of inflation, which if you're talking
about the gold price denominated in dollars, it's one
of the major indicators we would employ to make
judgments about the expectation for inflation.
At current prices, we're still more than nine times
what we were a generation ago ...
That is an important question and I don't think we
fully know the answer to that, but there is no doubt
that the decline in the gold price in the recent past
parallels the decline in inflation expectations which
we see elsewhere. I don't think there's any question
the Asian crisis has imparted a degree of disinflation
to the rest of the world. I think that's evident and I
don't think we see the full impact as of yet. You have
to remember that a goodly part of that has come in
the form of goods, tradeable goods. And tradeable
goods, while important to our economy, reflect a not
very large part of the overall business structure that
we've got. If you take non-farm business, goods
production is a third of it. The big part is services.
----------
Alas, Barney Frank had him on a hook, but let him off. Greenspan
agreed that gold is a major indicator of inflation expectations, but went on to say that the gold price is nine times what it was a generation ago. This allows him to argue that gold could still be signaling inflation -- being up nine times -- without having to answer the fact that it has fallen 20% in the last year. Greenspan also dodges behind the word "disinflation" to blame the Asians for "imparting a degree of disinflation to the rest of the world." Is "disinflation" another word for "deflation"? At the end of the
exercise, all we know is that Greenspan has avoided any scintilla of
blame for what is going on in the world, when in fact his conduct is
central to the worldwide deflation.
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